Tenneco’s Kenneth Trammell

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The U.S. auto industry is sputtering in low gear, as tight credit and consumer fears choke Detroit’s sales. Kenneth Trammell, CFO of Tenneco Inc., a $6.2 billion maker of automotive emission and ride-control systems, watched the industry make a sharp turn in the first quarter of 2008 when consumers suddenly abandoned SUVs and pickup trucks for smaller, fuel-efficient vehicles. The switch might have signaled hard times ahead for the auto-parts supplier except for two things: diversification and regulation. With 58 percent of its profits currently originating overseas and a series of global emissions rules set to be mandated, Tenneco has a buffer against the ill winds of the North American market. Of course, the 48-year-old Trammell admits, the recent government bailout of the industry — in the form of a $25 billion guaranteed loan package — doesn’t hurt either.

As an auto-parts supplier, you’ve been hit with everything from record gas prices to higher commodity costs. What had the biggest impact in the first half of the year?

What really drove our earnings down was the production environment in North America. Just as American Axle settled its strike in May, there was a series of announcements about [reduced] production schedules for light trucks and SUVs.… Ford announced it had to forgo its goal to return to profitability in 2009, which [meant] significantly reducing production of trucks and SUVs. General Motors announced first it was going to reduce shifts and then close plants for trucks and SUVs. Probably the biggest surprise was Toyota’s announcement that it would cease production of the Toyota Tundra pickup for three months.

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How quickly it happened. Everybody recognized that although North American buyers liked big vehicles, a significant change in fuel prices could change those preferences. Nevertheless, it happened faster than any of us would have predicted.

Do you do scenario planning?

Yes we do. We make sure that each of our locations is prepared to deal with a very rapid change in production. For example, when American Axle went on strike and shut down production of GM’s largest platform at the end of February, the [Tenneco] plant that served that platform had a contingency plan that they literally pulled off the shelf. It included how to handle employee discussions, who to put on temporary furlough, which vendors to tell to stop shipping product, and [how to] make sure that there was as small an impact as possible on both our earnings and our cash flow.… But we did not predict at the beginning of the year that we would have a production environment this low.

Despite being surprised by the sudden drop in demand, you put a premium on your ability to be nimble?

Yes, and it’s not just flexibility in our operations that we address, but also flexibility in how we manage our balance sheet. We’re fairly highly leveraged, so we need to make sure that in the event of a downturn we don’t have financial issues to deal with. So we have plenty of room on our debt covenants; we have enough liquidity; we have no near-term debt maturities. In fact, back in March of 2007, we redid our five-year revolving-credit agreement.

Given the current credit situation, are you breathing a sigh of relief?

The previous agreement would have expired at the end of 2008. So if we had been trying to redo it anytime in the last six months, the outcome would have been very different. We’ve always followed the rule that as a non-investment-grade company we finance when the market is ready, not when Tenneco is ready. And that has really paid off for us.

Every indication is that the switch to smaller vehicles is going to be permanent. How do you measure the future impact on your business?

We’ve been planning for a number of years to diversify our customer base beyond the traditional light-vehicle [passenger cars and light trucks] elites. And we are capturing business with a number of new commercial vehicles [thanks to new] environmental regulations around the world. For example, we have 37 contracts for regulation changes for diesel engines that start in 2010. Of those, 21 are commercial-vehicle contracts.

And that’s just part of a broader push for new emission controls worldwide?

From 2007 to the middle of the next decade will be the most intense period we’ve ever seen for environmental regulations for vehicles. In 2010, for example, there will be a change for on-road commercial vehicles in the United States and a change for diesel engines in China. In 2011, off-road diesel rules will come into effect in the United States and in Europe. Then, in 2014, there will be the next stage of off-road rules in the United States and Europe to address [nitrogen oxide] emissions. That’s just a small subset of all the regulation changes that are coming around the world.

How important to the auto industry, and to Tenneco, is the government’s $25 billion subsidy?

It can help OEMs and suppliers accelerate the retooling and transformation of U.S. manufacturing plants to produce the next generation of fuel-efficient cars and trucks. It’s important to Tenneco as a result. We will also explore opportunities to tap some of this capital.

Is it enough to guarantee improvement in 2009?

Improvement in 2009 will depend on the overall economy. Consumers need to buy cars.